‘Fragile situation’ spooks shares

Global financial markets are at a tipping point amid growing concerns that France and Germany won’t be able to come up with an ironclad agreement to solve Europe’s deepening debt crisis.

Ahead of this weekend’s summit meeting in Brussels, investors are ditching risky assets, worried that after almost two years of good intentions the debt problems of Greece will not be contained and the global economy is at risk of a major slowdown brought on by the European banks exposed to the peripheral country.

Thousands of workers marched through the streets of Athens as the Greek Parliament was due overnight to vote on more spending cuts, while French President
Nicolas Sarkozy
made an unexpected trip to Frankfurt to meet with German Chancellor
Angela Merkel
to discuss ways of increasing the size of the euro zone bailout fund.

The Australian sharemarket slumped 1.6 per cent yesterday, or 68.8 points, to 4144.9, dragged down by falls in key blue chips BHP Billiton, Rio Tinto and the four major banks.

The Australian dollar fell almost US2¢, changing hands at $US1.018¢ in early European trading, while euro zone sharemarkets were all down by around 1 per cent when they began trading overnight.

Investors were also spooked by World Bank chief
Robert Zoellick
when he described what was happening in Europe as a “fragile situation" but added the “big concerns" right now were the enormous US debt levels along with its recent cut in its credit rating.

“What I’m most worried about are problems in the developed world that will drag down the developing world," Zoellick told an audience at the University of Michigan.

A little over two weeks ago financial markets were pricing in a meltdown scenario in Europe along with a US recession. But on the back of a pledge from Merkel and Sarkozy to sort out Europe’s problems, along with better economic data in the US, sharemarkets around the world recovered sharply

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Emboldened by comments from the two leaders that the region’s banks would be recapitalised and a new series of measures to stabilise the euro zone would be soon be announced, shares began to rise.

US and Asian shares were up as much as 15 per cent, while European shares rose 14 per cent and Australian shares gained around 10 per cent.

However, some of the gains are now being unwound due to conflicting signals from Germany this week regarding the exact size of any rescue package, how it would work and who will pay for it.

This also made European banks wary of lending to each other and on Tuesday night they tapped the European Central Bank for almost €5 billion ($6.7 billion), the highest in more than seven months, according to Goldman Sachs.

Banks that use the funds are hit with a 2.25 per cent penalty rate and so the emergency facility is normally used sparingly and for no more than a day or two. But for the past two weeks it has been lending as much as €3 billion a day.

Yesterday Reserve Bank of Australia assistant governor Malcolm Edey said that local banks had little direct exposure to risky European government debt and were more resilient to volatile international markets.

“Our banks are profitable and well capitalised and their overall asset quality remains good,’’ he said in Sydney.

European policymakers have flagged that one way to help the crisis would be to increase the size of the European Financial Stability Facility to as much as €2 trillion, up from its current level of €440 billion.

But a sticking point is Sarkozy, who wants to turn the facility into a bank rather than risk losing France’s coveted AAA credit rating.

Greece has debts of about €350 billion and could be bankrolled if the European economy were firing on all cylinders, but the real concern for leaders is the precedent any rescue package sets in relation to how they will treat other countries that struggle under their debt burdens.